Transcripts of the monetary policymaking body of the Federal Reserve from 2002–2008.

Thank you, Mr. Chairman. With respect to policy, I also favor alternative A, a 50 basis point rate cut. Let me explain my reasoning. Otherwise I certainly agree with what President Rosengren said. First, I think the equilibrium real rate of interest is low relative to its long-run average. The range of medium-run measures of r* reported in the Bluebook is between 1.8 and 2.3 percent, and this range includes the Greenbook-consistent measure and the staff’s Kalman filter model estimate of 2.1 percent. Market perceptions of future real interest rates are also very low, with yields on five-year Treasury inflation-indexed bonds now below 1¼ percent. I think the headwinds from financial market turmoil and the more general reassessment of risks that is taking place in global markets are good reasons why the equilibrium real rate may be low in the current situation. We do have historical precedence for this. For example, Kalman filter estimates of r* fell noticeably during the credit crunch of the early 1990s.

Given the current state of the economy with inflation near a level consistent with price stability and resource utilization near its equilibrium level, policy should be close to neutral, which implies a nominal funds rate of 4 to 4¼ percent. The forecast and risk assessment must also enter the analysis. With an assumed 25 basis point cut at this meeting, the Greenbook foresees the economy barely skirting a recession, so any more bad news could put us over the edge; and the possibility of getting bad news—in particular, a significant credit crunch—seems far from remote. To my mind, the risk to the forecast and the risk of a vicious cycle, in which deteriorating financial conditions and a weakening economy and house prices feed on each other, argue for adopting a risk-management strategy that, at the very minimum, moves our policy stance to the low end of neutral—namely, a cut of 50 basis points—and I think it argues for doing so now rather than taking a “wait and see” approach and lowering it only grudgingly. This may not be enough to avoid a recession—we may soon need outright accommodation—but it would at least help cushion the blow and lessen the risk of a prolonged downturn. I should also say that my recommendation assumes that the implementation of the TAF, even if it succeeds in improving liquidity in the money market, will not appreciably alleviate macroeconomic conditions.

Regardless of the policy actions taken at this meeting, I think we need to be very careful in these unsettled conditions about how we communicate our assessment of risks and likely future policy actions. We should maintain maximum flexibility so that our future actions can, in Governor Kohn’s well-chosen words, be nimble. If the Committee chooses to cut the funds rate 50 points, I would favor the assessment of risks from section 4, alternative B, in table 1. This appropriately leaves open what the future policy will be and stresses that it depends on developments. If the Committee goes with the 25 basis point cut, then I would support using the assessment of risks from section 4, alternative C, which states clearly that the predominant concern is the downside risk to growth. Otherwise I fear that market participants may mark up their expected path for policy over the next year, leading to further erosion in financial conditions. Finally, I would suggest that, given the long period of time between today and the next FOMC meeting, we be open to the possibility of a special intermeeting videoconference to assess economic and financial developments, and this meeting could also benefit from an assessment of the effects of the TAF once it’s in place.

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